Tuesday, April 19, 2011

Yuan's Role in China Trade Grows Quickly

Yuan's Role in China Trade Grows Quickly

By AARON BACK

BEIJING—About 7% of China's foreign trade in the first quarter was done in transactions denominated in yuan, up from 0.5% a year earlier, illustrating the Chinese currency's rapidly growing—though still small—international role.

China's banks handled a total of 360.3 billion yuan ($55.2 billion) in cross-border trade deals denominated in the Chinese currency in the first three months of the year, Xinhua news agency reported Monday, citing a central-bank official. The volume was up from 309.3 billion yuan in the fourth quarter of 2010, or 5.7% of foreign trade, and was nearly 20 times the 18.4 billion yuan in such deals in the first quarter of 2010, according to earlier data from the People's Bank of China.

.Until a couple of years ago, effectively all of China's foreign trade was done in dollars or, to a much lesser extent, other foreign currencies, a byproduct of the country's tight controls on the use of its currency outside its borders.

Since the global financial crisis, however, China's leaders have become increasingly determined to reduce the use of the U.S. dollar. In recent months, they have aggressively pushed the expansion of yuan trading outside mainland China, setting up Hong Kong as a trading hub and encouraging yuan trading in major financial centers such as New York and London. They also have entered into deals with Russia and Brazil to give companies the option of settling trade deals in local currency rather than in dollars. And Chinese officials have allowed some foreign firms to issue bonds in yuan, including Caterpillar Inc., McDonald's Corp. and Unilever NV.

In 2009, the government began allowing exporters and importers in certain regions to use yuan to buy or sell goods abroad with specified trading patterns. The trials started slowly—yuan deals accounted for just 0.1% of total trade in the 2009 fourth quarter—but have expanded rapidly.

The process has been helped by the government's move last June to let the yuan start appreciating against the dollar, albeit gradually. Perceptions that the yuan is undervalued and is therefore likely to appreciate have made trading companies outside China more willing to take the currency as payment.

Indeed, most of the yuan-based trade deals so far have involved Chinese companies using the Chinese currency to buy goods from others. The Chinese Academy of Social Sciences, a state-run think tank, said in a study issued Monday that about 80% of yuan trade in the first three quarters of 2010 was accounted for by China's imports.

Mark Williams, an economist at research firm Capital Economics, said there is likely a limit to how much foreigners will be willing to accept in yuan payments, because there are still strict curbs on their ability to invest those assets, the result of the still-extensive capital controls that help Beijing manage the yuan's exchange rate. "There's a contradiction between these aims to internationalize the currency on the one hand and to maintain your hold on the value of the currency on the other," he said. "You cannot achieve both those things over the long run."

The growing use of yuan to pay for imports also may be having the unintended effect of helping pump up the Chinese central bank's holdings of foreign currency, which soared by $197.4 billion in the first quarter, to $3.0447 trillion. That stockpile, which has more than tripled in the past five years, has created headaches for Beijing, which holds most of it in U.S. government debt and other dollar assets.

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Until a couple of years ago, effectively all of China's foreign trade was done in dollars or, to a much lesser extent, other foreign currencies, a byproduct of the country's tight controls on the use of its currency outside its borders.
.The central bank amasses those reserves because it must buy dollars that flow into the country from sources like exporters and foreign investors. In the past, when Chinese importers had to use foreign currency, they had to buy it from the central bank, which meant their purchases of foreign goods acted to reduce the size of the reserves. But payments that are made in yuan do nothing to eat into the reserves.

Economists say about $130 billion of the first quarter's increase in China's foreign-exchange reserves isn't explained by the usual causes, such as export revenue and foreign investment, indicating there may have been big inflows of speculative "hot money" during the quarter. Mr. Williams said, however, that the use of yuan to pay for imports could explain roughly $40 billion of that increase.

In other words, as long as yuan settlement is predominantly used for imports rather than exports, the central bank's efforts to internationalize the yuan will have the counterintuitive effect of increasing their holdings of dollars, and therefore the reliance on the U.S. currency—albeit perhaps not by a large amount relative to their overall size.

"Certainly this [is] going to be a trend in the future, that the more trade is settled in yuan, there is going to be a bigger accumulation of foreign-exchange assets," Mr. Williams said.

—Tom Orlik and Michael Casey contributed to this article.
Write to Aaron Back at aaron.back@dowjones.com